Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hengdian Group Tospo Lighting Co., Ltd. (SHSE:603303) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hengdian Group Tospo Lighting's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Hengdian Group Tospo Lighting had CN¥120.0m of debt, an increase on CN¥60.0m, over one year. However, it does have CN¥3.55b in cash offsetting this, leading to net cash of CN¥3.43b.
A Look At Hengdian Group Tospo Lighting's Liabilities
Zooming in on the latest balance sheet data, we can see that Hengdian Group Tospo Lighting had liabilities of CN¥2.96b due within 12 months and liabilities of CN¥33.2m due beyond that. Offsetting these obligations, it had cash of CN¥3.55b as well as receivables valued at CN¥1.26b due within 12 months. So it can boast CN¥1.82b more liquid assets than total liabilities.
This surplus strongly suggests that Hengdian Group Tospo Lighting has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Hengdian Group Tospo Lighting boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Hengdian Group Tospo Lighting grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hengdian Group Tospo Lighting can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hengdian Group Tospo Lighting may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Hengdian Group Tospo Lighting actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Hengdian Group Tospo Lighting has net cash of CN¥3.43b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥853m, being 222% of its EBIT. The bottom line is that we do not find Hengdian Group Tospo Lighting's debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Hengdian Group Tospo Lighting has 2 warning signs we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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